Hoff Explains Banking’s Trust Deficit

January 22, 2013

By Jonathan Lin

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More than five years since the financial crisis began in 2007, the United States is still reeling from its after-effects as low-growth and unemployment indicators continually remind us. Beneath all the numbers is the underlying issue of trust, and last week’s convocation speaker Ronald Henkoff presented on the systemic lack of trust in American banking.

A 1975 graduate of Carleton, Henkoff is professionally trained as a journalist and economist, and currently works at Bloomberg Markets magazine as executive editor. His talk, “Money, Power, and Trust,” gave a sobering account of the traumas and scandals that have befallen the US financial system in the last five years.

With only a twenty-one percent approval rating from Americans, the banking system stands as truly deficient in credibility. While covering a range of topics from word etymologies to nitty-gritty financial mechanics, Henkoff meticulously outlined the inception of the financial crisis. His delivery was clear, explanations accessible, and metaphors very colorful, as he explained the processing of poor mortgage loans and high-risk circulation of money.

His case study involved whistleblower Sherry Hunt, a former employee of Citibank who stood up to her superiors and drew attention to their deceitful concealment of poor-quality transactions. Throughout his talk, Henkoff moved away from Hunt’s story to explain how complex operations such as collateralized debt obligation (CDO) functioned, and how they contributed to the circulation of “toxic” subprime loans that led the entire system closer to collapse.

Henkoff promised to reduce the slew of technical jargon and only use three acronyms in his presentation. Though some Carls may suspect the economist to have forgotten the prevalence of acronyms on campus, Henkoff kept his word and the technicality of his talk to an appreciated minimum.

In discussing the role of government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac, he described how banks like Citi were duping both their customers and the government.

Bundles of mortgages can move around on what he called “a second market,” where the selling of wrecks is not immoral so long as it is reflected in the price. But Citigroup masked their poor-quality loans by “adjusting the car odometers, thus flooding the marketplace with junk but in effect saying the used cars were shiny and new.”

Bringing in the familiar term ‘Too Big To Fail,’ Henkoff introduced a concept that received far less attention: ‘Too Big To Indict.” Here lay the most worrisome issue: that no matter how egregious the crime, the bank will not be subject to criminal prosecution. This rests on the logic that banks are so integrated into the economy and the livelihoods of businesses and citizens that any indictment risks creating a ripple effect of even greater upheaval.

To Henkoff, the biggest grievance lay in the “moral hazard” looming over the banking system. “There exists the belief that pretty much anything you do to increase the revenue of your organization seems legitimate,” he said, before quoting a former bank CEO that though financial executives are not regarded as saints, “at least there should be some moral standard.” In the privileged positions they occupy, banks do require a license to operate, but many have nonetheless abused their powers to maximize profit with little regard of those they serve.

Henkoff concluded his talk by illustrating a variety of regulatory efforts that have been taken to combat such flagrant violations of trust. Although Hunt’s story ended well with the successful court battle over Citibank, there are far more unseen similar stories that do not shed light on the banking scandals. “Regulations must be a global effort to work, but even then newly established rules will go into effect after several years,” Henkoff noted, arguing that “instead of moral hazard, we need good old-fashioned morality.”